Disclaimer This edited version will be removed from the Database after 30 September 2025. If you believe the issues detailed in this edited version warrant retention in an alternative form, email publicguidance@ato.gov.au This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law. You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4. |
Edited version of private ruling
Authorisation Number: 1011570172029
This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.
Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.
Ruling
Subject: CGT - small business concessions - active asset - connected entities - controlling individual - rental exception
1. For the purposes of subparagraph 152-40(1)(a)(ii) of the Income Tax Assessment Act 1997 (ITAA 1997), does your portion of the commercial property satisfy the meaning of active asset from July 2001 until June 2004 by way of the business conducted by the Partnership and because of an affiliate relationship you had in terms of section 152-47 with your spouse and partner in the Partnership?
Yes.
2. From mid 2005 until mid 2010 has the Unit Trust been connected to you under section 328-125 of the ITAA 1997?
Yes.
3. For the purpose of section 152-35 of the ITAA 1997, will your portion of the commercial property satisfy the active asset test if sold prior to 30 June 2011?
Yes.
4. For the purposes of paragraph 152-40(4)(e) of the ITAA 1997, is the commercial property excluded from being an active asset because it is a capital gains tax (CGT) asset whose main use is to derive rent?
No.
This ruling applies for the following period:
Year ended 30 June 2011
Relevant facts and circumstances
This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.
Your spouse, you, Individual A and Individual B jointly purchased a commercial property for the purpose of establishing and operating a business. A considerable sum was spent fitting out the premises with specialised fixtures and fittings. By mid 2001 the business had commenced operating.
From mid 2001 until mid 2004 the business was conducted by the Partnership, the partners being your spouse and Individual A. From mid 2004 until present the business has been conducted by the Unit Trust.
The units in the Unit Trust are held 50% by the A Trust and 50% by the B Trust. Both the A Trust and the B Trust are discretionary.
Your spouse and you are beneficiaries of the A Trust. Individuals A and B are beneficiaries of the B Trust.
As the size of the property acquired exceeded the needs of the business a decision was made to rent the remaining space. Since commencing business in the premises the business has occupied 25% of the available space with the remaining 75% let to tenants.
You advise that total income from the business accounted for more than 90% of total income derived from the premises. The rental portion realised less than 10% of total income over this period.
From and including the year ended 30 June 2004, the A Trust has distributed the following income percentages to your spouse and you:
YEAR |
Spouse |
You |
2004 |
<40% |
<40% |
2005 |
>40% |
<40% |
2006 |
<40% |
<40% |
2007 |
<40% |
<40% |
2008 |
>40% |
<40% |
2009 |
<40% |
<40% |
From and including the year ended 30 June 2004, the B Trust has distributed certain income percentages to Individuals A and B.
The corporate trustee of both the A Trust and the B Trust is Co Pty Ltd. This company has issued two ordinary shares. Your spouse and you hold one share and Individuals A and B hold the other share. The directors are your spouse, you, and Individuals A and B.
Jointly, all four of you are proposing to dispose of the commercial property and intend to make a capital gain on the transaction.
You state that the property is expected to sell within the next few months. However, for the purposes of this ruling the total period of ownership if the property is disposed of on 30 June 2011 would be Q years and R months. As at a specified date the total period of ownership is S years and T months.
Relevant legislative provisions
Income Tax Assessment Act 1997, section 152-35
Income Tax Assessment Act 1997, subsection 152-35(2)
Income Tax Assessment Act 1997, section 152-40
Income Tax Assessment Act 1997, subparagraph 152-40(1)(a)(i)
Income Tax Assessment Act 1997, subparagraph 152-40(1)(a)(ii)
Income Tax Assessment Act 1997, subparagraph 152-40(1)(a)(iii)
Income Tax Assessment Act 1997, subsection 152-40(4)
Income Tax Assessment Act 1997, subsection 152-40(4)(e)
Income Tax Assessment Act 1997, section 152-47
Income Tax Assessment Act 1997, section 328-125
Income Tax Assessment Act 1997, section 328-125(2)
Income Tax Assessment Act 1997, section 328-125(3)
Income Tax Assessment Act 1997, section 328-125(4)
Income Tax Assessment Act 1997, section 328-125(4)(a)(ii)
Income Tax Assessment Act 1997, section 328-125(7)
Income Tax Assessment Act 1997, section 328-130
Does Part IVA apply to this ruling?
Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.
We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.
If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.
For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.
Reasons for decision
Note that all subsequent legislative references are to the ITAA 1997 unless otherwise stated.
Meaning of active asset
Section 152-40 provides the meaning of active asset. It states, in part, that a CGT asset of yours is an active asset if it is used or held ready for use by you, your affiliate, or an entity connected with you, in the course of carrying on a business (whether alone or in partnership).
Active asset test
If you have owned the CGT asset for less than 15 years the active asset test in section 152-35 will be satisfied if the asset was an active asset of yours for a total of at least half of a particular period as outlined in subsection 152-35(2). The period commences when you acquired the asset and ends at the earlier of either:
(i) the CGT event, or
(ii) if the relevant business ceased to be carried on in the 12 months before that time - the date on which the business ceased.
Connected entities
An individual may be connected with a unit trust if he/she controls that entity in a way described in section 328-125.
In accordance with subsection 328-125(7), where an individual fails to establish direct control of the unit trust, he/she may establish indirect control of it via an interposed entity. This can be achieved provided that the individual either directly or indirectly controls the interposed entity and the interposed entity in turn either directly or indirectly controls the unit trust.
In the event that the interposed entity is a discretionary trust, subsection 328-125(2) provides that the discretionary trust may directly control a unit trust if the discretionary trust beneficially owns interests that carry the right to receive a percentage (the control percentage) that is at least 40% of any distribution of income or capital by the unit trust.
Direct control of a discretionary trust may be established via either of two paths. Subsection 328-125(3) or subsection 328-125(4).
Subsection 328-125(3) provides that an individual controls a discretionary trust if the trustee of that trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the individual, his/her affiliates, or the individual together with his/her affiliates.
Subsection 328-125(4) provides, in part, that an individual directly controls a discretionary trust for an income year if, for any of the preceding four income years, the discretionary trust distributed at least 40% of any income or capital paid for that year to either the individual, the individual's affiliates, or to the individual together with any of his/her affiliates.
In summary, if the individual directly controls the discretionary trust via either subsection 328-125(3) or subsection 328-125(4) and the discretionary trust directly controls the unit trust in accordance with subsection 328-125(2), then by virtue of subsection 328-125(7) the individual is also taken to indirectly control the unit trust and be connected to it under section 328-125 for the purposes of the meaning of active asset in subparagraph 152-40(1)(a)(iii).
Affiliates
In part, section 328-130 states that:
An individual…is an affiliate of yours if the individual…acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual…
Note that for the purpose of the meaning of active asset under section 152-40, section 152-47 deals with passively held CGT assets. It provides, in part, that if the asset owner has an asset which is used, or held ready for use, in the course of carrying on a business in an income year by a separate business entity and that business entity is not (apart from this subdivision) an affiliate of the asset owner then, for the purpose of this subdivision in determining whether the business entity is an affiliate of the asset owner, both a spouse of an individual and a child of an individual who is under the age of 18 automatically qualify as affiliates of that individual.
The Advanced guide to capital gains tax concessions for small business (NAT 335) indicates that section 152-47, although introduced on 19 March 2009, is retrospective in relation to this issue.
Rental exception
Certain assets are excluded from being active assets under subsection 152-40(4). Paragraph 152-40(4)(e) excludes, among other things, assets whose main use is to derive rent (unless such use was only temporary).
The rental exception is discussed in Taxation Determination TD 2006/78 and the Advanced guide to CGT concessions for small business. These ATO view documents provide that if an asset is used partly for business purposes and partly to derive rent then it will be a question of fact dependent upon the circumstances of each case as to whether the assets main use is to derive rent. Factors to be taken into account include comparative areas of use and comparative levels of income.
Application to your circumstances
For all four individuals, the ownership interest in the commercial property will be considered an active asset if you can each meet the requirements of section 152-40 for the period stated in section 152-35.
Provided the Unit Trust continues to operate the business up until the time of disposing of the property, then if it was sold on the date of the preparation of this ruling then the period for which active asset status would need to be established is half of S years and T months. If the property was sold by 30 June 2011 then the period for which active asset status would need to be established is half of Q years R months.
Whilst you were not a partner in the Partnership which conducted the business from mid 2001 until mid 2004, you were considered an affiliate of your spouse due to the operation of section 152-47, and they were a partner. Accordingly, you accumulated an active asset period of three years in terms of subparagraph 152-40(1)(a)(ii).
From mid 2004 when the Unit Trust became the business owner the path to active asset status for you changed. For the purposes of subparagraph 152-40(1)(a)(iii) you needed to establish that you controlled and were connected to the Unit Trust under section 328-125.
You are not directly connected to the Unit Trust because your ownership entitlements flow through the A Trust. It follows that you must attain connected entity status via subsection 328-125(7). This subsection introduces the concept of an intermediate entity.
As the A Trust is a discretionary trust you must establish control of it via either subsection 328-125(3) or 328-125(4).
In terms of subsection 328-125(4) the facts presented provide that the A Trust allocated a >40% distribution to your spouse in the years ended 30 June 2005 and 30 June 2008 respectively. As these amounts are greater than 40% and you are your spouses affiliate by virtue of subparagraph 328-125(4)(a)(ii), you are able to show that you directly controlled the A Trust from mid 2005 up until present.
As the A Trust has held 50% of the units in the Unit Trust since it took over the business, the 40% requirement needed to establish control under subsection 328-125(2) has been met continuously since mid 2004.
As you controlled the A Trust from July 2005 and the A Trust controlled the Unit Trust from mid 2004 it follows that both requirements were simultaneously met from mid 2005 and you indirectly controlled the Unit Trust from that date onwards. Consequently, you have also been indirectly connected with the Unit Trust via the operation of subsection 328-125(7) from mid 2005.
For the purposes of subparagraph 152-40(1)(a)(iii) you are considered to be connected with the Unit Trust which has been conducting the business from mid 2005 until present. As such, you have accumulated a further active asset period of U years and V months.
When the two periods are added together the total active asset period is W years and X months out of the S years and T months for which the commercial property has been held. This easily exceeds the period required for the purpose of section 152-35 regardless of whether it is sold now or as late as 30 June 2011. Accordingly, upon disposal your 25% portion of the commercial property will have passed the active asset test.
Note, as your have passed the active asset test using subsection 328-125(4) there is no need to consider the alternate subsection 328-125(3).
Rental Exception
For the purposes of the rental exception in paragraph 152-40(4)(e) you advise that since commencing the business the business has occupied 25% of the available floor space with the remainder let to tenants. You also advise that total income from the business accounted for more than 90% of total income derived from the premises. The rental portion realised less than 10% of total income over this period.
With reference to TD 2006/78, whilst somewhat less than a majority of the available area within the commercial property is used for business purposes the business proportion of the land derives a vast majority of the total income and the business occupied a significant area of the property.
Combined with the fact that most of time attributable between the two activities would be spent on the business we consider that the main use of the property is not to derive rent and accordingly it will not be excluded from being an active asset by paragraph 152-40(4)(e).
Copyright notice
© Australian Taxation Office for the Commonwealth of Australia
You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).